The exploding income gap

Powerful new congressional testimony highlights the need for national policy reforms

The next time you're feeling burdened by the mess in Washington and beginning to think that the economic and fiscal policy challenges facing our country may simply be beyond hope, take a deep breath, fire up your computer, get on the internet and go to www.cbpp.org[1], the website of the national public policy think tank known as the Center on Budget and Policy Priorities.

There, to your relief, you will find that a tireless team of enormously smart and progressive people are working hard every day to diagnose the ills of our economy and government and formulate coherent and forward-looking solutions. Each time you visit, you will be impressed and encouraged by the group's collective insight, its commitment to social and economic justice, and its plain spoken and common sense policy prescriptions. The site ought to be required daily reading for every high official in the federal government.

Income inequality

The Center's latest excellent contribution to the national policy debate came this week in the form of testimony offered by its executive director, Bob Greenstein, to the House Committee on Ways and Means. The subject of Greenstein's testimony was national income inequality – recent developments, historical trends, the roles that public policy has played in giving rise to these trends and developments, and a list of some of the specific things we can and should do to address the problem. The presentation serves as a powerful reminder that America's problems are, contrary to the contentions of the market fundamentalists, fully within our ability to directly and intentionally influence with straightforward public policies.

"In recent years, income inequality in the United States rose to historically high levels. This was not because the economy was in a recession – the latest available data on inequality do not reflect the current economic slump. And it was not a new development. Inequality has been increasing for more than 30 years.

There was, however, something different about the increase in inequality from 2001 until last year…. The disconnect in recent years between how the overall economy was doing statistically and how most people living in that economy were doing was puzzling to some pundits and some elected officials and their advisors. But it really was not that complicated. First, the post-2001 period was the weakest of all economic expansions since World War II by almost every economic measure. Second, to an unprecedented degree, the gains from economic growth after 2001 accrued to a narrow slice of the population at the top of the income distribution.

When I said the recovery was weak by almost every measure, I was alluding to the fact that there was one important exception – corporate profits. While aggregate wages and salaries grew less than half as fast after 2001 as they did in the average postwar economic expansion, corporate profits grew almost 30 percent faster. Both employment growth and wage and salary growth were weaker in the most recent expansion than in any prior expansion since the end of World War II; growth in corporate profits was stronger than the average of all post World War II expansions."

The statistics –

According to Greenstein, from 1976 to 2005, the after-tax incomes of various income groups (in 2005 dollars) increased as follows:

The bottom 20% – $900 or 6.3%

The second 20% – $4,600 or 15.8%

The middle 20% – $8,700 or 21%

The fourth 20% – $16,000 or 29.5%

The top 20% – $76,500 or 79.9%

The top 1% – $745,100 or 228.3%

Greenstein also notes that, despite it phenomenal growth, income inequality "pales in comparison to the inequality in the distribution of wealth." In contrast, he notes, from 1946 to 1975, the gap between rich and poor in the U.S. actually narrowed.

How government policies abetted this process –

Greenstein endorses the idea voiced by many economists that the change in incomes and wealth is the result of a "constellation" of private and public forces. But he also supports the idea that there is a clear link between the growth in income gaps and the long-term erosion of the progressivity of the federal tax code – especially in recent years. In other words, market changes may have harmed average Americans, but the tax code has essentially "piled on." He notes that the 2001-2003 tax cuts have provided large and disproportionate windfalls to the richest Americans.

"The CBO data are clear about effective tax rates at the top: they are lower than they have been since at least 1979. These data show that the tax system has become less progressive. The share of taxes paid by high-income households has been going up, but this is because these are the households that have gotten most of the increase in before-tax income. Their income gains have been so large that they are paying more in taxes even though they have gotten substantial tax cuts and the percentage of their income that they pay in taxes has gone down."

Policy implications for 2009 and beyond –

"The United States faces a number of tough challenges ahead. The new ones caused by the current financial crisis are front and center right now, but the others have not gone away, including an unsustainable long-term deficit, the need for health care reform, fundamental tax reform, and the need to address climate change. The problem of widening income inequality is exceedingly unlikely to go away on its own. But how we address these other critical challenges also will have important implications for whether policymakers make inequality worse or better through their policy actions."

So what is Greenstein's prescription for getting ourselves out of the current mess in a safe and sane way? In short it's this: Promote strong economic growth and rising productivity, but don't turn things completely over to market forces. We must remain intentional and vigilant in combating the inequality that inevitably results from unfettered markets. This means taking direct and concrete steps to:

Reduce poverty. As Greenstein notes, America's persistently high poverty rate is a self-perpetuating drag on the economy. Aggressive solutions, like the "Half in Ten"[3] idea proposed by John Edwards and others earlier this year, deserve serious consideration.

Reform the tax code. Greenstein highlights the need to shift the code away from tax deductions that target high income households toward refundable tax credits that are more accessible to folks of modest income. This would have the twin advantage of improving progressivity and promoting more desirable behavior (like spending on education) without expanding costs.

Increase investments in pre-school education and childcare subsidies. This, of course, would allow more low and moderate income parents to work and spur educational attainment.

Patch the holes in the safety net. As the nation enters a period of serious economic recession, we simply must modernize our unemployment insurance system and other basic assistance programs to prevent explosive growth in human misery.

Going forward

The coming months and years promise to be incredibly challenging for the new President and Congress. America is at an economic and fiscal crossroads that will require a calm and steady hand and a deep commitment to making our market economy work for a far broader cross-section of the population than has benefited during the last decade. Heeding the advice of the experts at the Center on Budget and Policy Priorities would be an excellent place to start such an effort.